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Google’s Alphabet could stifle innovation

A conference attendee looks through "Cardboard," a viewer that enables the user to view content from a smart phone in 3D, during the Google I/O developers conference in San FranciscoA conference attendee looks through "Cardboard," a viewer that enables the user to view content from a smart phone in 3D, during the Google I/O developers conference in San Francisco
A conference attendee looks through "Cardboard," a viewer that enables the user to view content from a smart phone in 3D, during the Google I/O developers conference in San Francisco, California May 28, 2015. REUTERS/Robert Galbraith - RTX1F04QPhotograph by Robert Galbraith — Reuters

Google surprised analysts and investors this week when the tech giant announced the creation of a new holding company called Alphabet and the separation of its search, maps, YouTube, Gmail, and other core businesses into a discrete division, which will retain the original name and be run by Sundar Pichai.

From a purely shareholder value standpoint, it’s a smart move.

Google (GOOG) has become as synonymous with technological experiments, such as Internet-delivery balloons, cancer detection pills, drones, and robotics, as with Internet search. That’s a problem for Google investors, who invest primarily in its current suite of products and only tangentially in possible future products – many of which might never take off. It’s also a difficult portfolio to manage because of its diversity and a tough story for the market to follow.

 

By separating its speculative ventures into independent divisions, Google is hoping to create a more organized structure for its businesses as well as a partial shield for its core business from the vagaries of experimentation. Even though the core business, fueled by advertising, would still fund R&D for the entire enterprise, the other divisions will now face greater investor scrutiny by virtue of being separate and (at least collectively) more transparent. By the last three months of this year, the company plans to report separate financial results for its Google business and Alphabet divisions, according to The Wall Street Journal.

What this means is that the impact of the company’s unprofitable ventures on its overall bottom line will become more evident and could lead to those divisions being sold or shut down, thereby enhancing returns for shareholders. That’s particularly relevant for Google’s so-called ‘moonshots,’ such as self-driving cars and smart contact lenses.

But while this could encourage the company to pursue rational strategic alternatives for individual divisions and be good for optimization of the stock price, it could also put a serious damper on the spirit of innovation. Excessive analyst and shareholder focus on original R&D at Alphabet, especially when the payoff may be years away or indirect, could be detrimental to pure creativity.

Another consideration is that while the conglomerate model might work for companies like Berkshire Hathaway (BRK), whose portfolio of financial services, energy, and manufacturing firms arguably don’t require a tremendous amount of R&D, technology companies that thrive on cutting- edge discoveries are ill-served by this. It’s also not easy to manage a conglomerate, a fact that was borne out when the popular business model fell apart in the period from the 1970s to the 1990s.

To be fair, Google’s move could also spur fundamental research by attracting (and allowing) outside investments for its explorative projects through private placements or tracking stocks, which are tied to discrete business lines within a larger company, and it’s unclear just how granular the company’s financial reporting will eventually be. It’s entirely possible that the new structure will turn out to be mostly cosmetic and have little impact on how Google co-founders Larry Page and Sergey Brin spend Google’s money.

But if the company’s aim really is to insulate its core business from exposure to experimental research, then it’s hard to see how the spigot isn’t going to be tightened eventually. That could be bad news for the tech world.

S. Kumar is a tech and business commentator. He has worked in technology, media and telecom investment banking. He does not own shares of Google or other companies in this article.